1031 Exchange Prevented by CV19

I have a client who complied with all IRS 1031 real estate exchange requirements in 2020 but was prevented from completing the exchange because of the pandemic when the lender on the replacement property pulled out at the last minute and no one else would make the loan because of the pandemic. I prepared his return reporting the sale and gain and we attached a letter explaining why he requested a waiver of the gain due to the Covid emergency. Needless to say both his State and the IRS are still requesting the substantial capital gains amount. When my client attempted to appeal the request to his State he was informed that there is a statute that says a taxpayer can't appeal something on his own return that he reports he owes and can only appeal determinations of assessed amounts from the State, as from an audit for example.

So now my client wants to submit an amended return reporting the gain but somehow also reporting on the return that no capital gains tax is owed because CV19 prevented its completion, so at least when the amended return is submitted and the IRS or State still want a payment it's based on their determination and can therefore then be appealed. Looking for the best way to do this on the return. I've thought of somehow characterizing it as a casualty loss or something similar but I'm still not certain of the best way or if there is a way to accomplish what I need. Any suggestions or ideas would be appreciated.

Didn't Notice 2020-23 address the extension available for COVID related issues with existing 1031 exchanges? If the exchange was not completed within the required timeframe on what grounds would you be requesting any kind of relief?

All 1031 requirements were met and completed in a timely manner. No extensions were necessary. My client will be requesting relief on the grounds that the pandemic disaster prevented the completion of the 1031. This thread is focused on possible methods of how to report the sale and gain on the amended return, while at the same time showing it as not being owed, or being reduced to zero because of an offset or casualty loss, which even if disallowed, which is probably likely, then gives him a basis to appeal that decision.

All 1031 requirements were met and completed in a timely manner. No extensions were necessary. My client will be requesting relief on the grounds that the pandemic disaster prevented the completion of the 1031. This thread is focused on possible methods of how to report the sale and gain on the amended return, while at the same time showing it as not being owed, or being abated or mitigated, which even if disallowed, which is probably likely, then gives him a basis to appeal that decision.

Which is it?

I'm thinking you're wasting your time on this. If I understand the facts correctly, a tax was reported on a 1040, but not paid. That means it was assessed and the file is in Collections. I doubt Collections would cease on the filing of the 1040X and I don't think Appeals has jurisdiction regarding an adverse decision regarding a 1040X.

My impression is that you intend to seek relief from a tax liability on equitable grounds without authority. I am quite pessimistic, but I suggest you look into a 656 based on effective tax administration. If you have a legal argument that I'm not aware of, then a 656 based on doubt as to liability would be appropriate.

Which is it?

It's both. Obviously if it was completed in it entirety the tax would have been deferred and there wouldn't be an issue with tax liability. My client followed all the regulations in a timely manner and then his lender bailed at the last minute because of CV19 and no other lenders would lend on a vacation rental property when vacation rentals were shut down. So, but for the pandemic, the transaction would have completed and the tax amount he now owes would have been deferred. Again, this is not the thrust of this thread.

I'm thinking you're wasting your time on this. If I understand the facts correctly, a tax was reported on a 1040, but not paid. That means it was assessed and the file is in Collections. I doubt Collections would cease on the filing of the 1040X and I don't think Appeals has jurisdiction regarding an adverse decision regarding a 1040X.

My impression is that you intend to seek relief from a tax liability on equitable grounds without authority. I am quite pessimistic, but I suggest you look into a 656 based on effective tax administration. If you have a legal argument that I'm not aware of, then a 656 based on doubt as to liability would be appropriate.

The file is not in collections yet. My client actually contacted the IRS and his State months earlier in a proactive way asking how to best remedy this and never got a response. Thanks for your input.

The key to dealing with the IRS is to get the file on the desk of someone who has the authority (i.e., discretion) to give your client whatever it may be your client is seeking.

When, if at all, was the replacement property purchased?

How much gain are we talking about?

When, if at all, was the replacement property purchased?

How much gain are we talking about?

The gain is substantial or he would just pay it. As I've stated previously, if the replacement property would have been purchased, the gain would have been deferred and I wouldn't be on here asking for creative methods to file an amended return where the original sale is reported but that the capital gains tax portion shows as zero and is not due - even if the State or IRS challenge that position. When they do challenge it, my client then has a basis for appealing their decision. Now he does not, at least on the State level. It's too soon to know yet what is happening with the IRS. He's trying to get the Taxpayer Advocate Service to assist him. His greatest need right now is to get an amended return filed as soon as possible to help call off the State collection dogs.

No disrespect intended but I was under the impression that there were some sharp tax preparers here that might come up with some creative methods or ideas to accomplish what I'm asking help with.

Is the qualified intermediary still holding the funds from the sale? Has the TP tried to identify another property to purchase? If so, was it done within a reasonable time to the sale? What actions is he now taking to deal with the problem? What actions did he take immediately after finding out he could not get financing? Provide details on steps taxpayer is taking or has taken to correct the situation.

Why didn’t he use the proceeds from the sale to purchase the replacement property?

In your posts, you have offered no arguments as to why the tax is not currently due. The fact he could not get financing is not one. TP s/ have had that lined up before he even started the 1031 exchange for the very reasons you state here.

Unless there is something in the details you have not provided, I think he owes the taxes now. I am not aware of any COVID provisions extending the timelines for 1031 exchanges, other than those already mentioned, but if you have very specific facts on how he has tried to mitigate the problem, those MIGHT help to reduce penalties, if any.

As I've stated previously, if the replacement property would have been purchased,

Excuse me, but that’s not all you stated. You stated this:

All 1031 requirements were met and completed in a timely manner.

Isn’t one of the requirements to timely acquire replacement property (as SJR points out)? Yes, it is. Therefore, your client did not meet all 1031 requirements. Not even close. Your client got the cash, from a sale, did not timely replace, and now you want to take the position that there was not a taxable sale.

Gator has it right when he says you’re wasting your time.

No disrespect intended but I was under the impression that there were some sharp tax preparers here that might come up with some creative methods or ideas to accomplish what I'm asking help with.

No preparer here will tell you to commit a fraud by filing an amended return that takes a frivilous position that a taxable sale wasn’t a taxable sale.

I've thought of somehow characterizing it as a casualty loss or something similar

There is no loss here, only a gain. The guy kept the cash, so what did he lose? Nothing.

I prepared his return reporting the sale and gain and we attached a letter explaining why he requested a waiver of the gain due to the Covid emergency.

My client actually contacted the IRS and his State months earlier in a proactive way asking how to best remedy this and never got a response.

He's trying to get the Taxpayer Advocate Service to assist him.

Good grief.

Obviously if it was completed in it entirety the tax would have been deferred and there wouldn't be an issue with tax liability.

Yeah, and he wouldn’t have the cash either.

No disrespect intended, you say you are from Earth, but you are not applying any tax logic that we are accustomed to seeing here on Earth.

Also vacation rental properties typically have a personal use element. Are you sure the properties qualified for 1031 had he been able to complete it?

I’ve had several clients get loans on vacation property in the last two years. Was the TP turned down because he was using projected income from the property to qualify for the loan?

Not that it matters. Just curious.

Good answer, Jeff.

I have a client who complied with all IRS 1031 real estate exchange requirements in 2020 but was prevented from completing the exchange because of the pandemic when the lender on the replacement property pulled out at the last minute.
Any suggestions or ideas would be appreciated.

Are you sure your client is telling you the whole story?

What does he mean at the 'last minute"?

Was this just before closing and loan had been approved?

How much of the purchase price of the replacement property did the loan represent?

As others have posted here, there is really nothing the IRS can do in this situation, unlike a hardship waiver for the 60 day roll over rule of 402(c)(3)(B).

I believe that relief can only come from a presidential declaration which has come and gone.

Isn’t one of the requirements to timely acquire replacement property (as SJR points out)? Yes, it is. Therefore, your client did not meet all 1031 requirements. Not even close. Your client got the cash, from a sale, did not timely replace, and now you want to take the position that there was not a taxable sale.

He did everything in a timely manner, so you are uninformed. The loans were drawn, the title company had the loan documents for the replacement property and the day he was set to go in and sign them, the lender pulled the loan because of covid. No other lenders would loan at that particular time including the seller. So, again, but for the Covid pandemic disaster the 1031 would have closed and the gain would have been deferred.

No preparer here will tell you to commit a fraud by filing an amended return that takes a frivilous position that a taxable sale wasn’t a taxable sale.

FRAUD? It would be fraud if he didn't report the sale. He reported it and we're simply looking for creative ways to have the State and IRS let us argue via an amended return that in a time when they are helping people impacted by Covid with stimulus checks, PPP loans, etc, that it's not equitable to at the same time impose a capital gains tax that only became due because of the same pandemic conditions. Right now the State won't even HEAR the arguments because we reported the gain on the original tax return and they won't allow an appeal on a tax your return shows you owe them.

There is no loss here, only a gain. The guy kept the cash, so what did he lose? Nothing.

FRIVOLOUS? Are you really this uninformed? If you sell a property and realize a taxable gain of a million dollars and the government lets you defer that gain and the tax due on it by means of a 1031 Exchange replacement property, how do you not lose the money if the gain can't be deferred and the IRS instead asks for the tax on it?

No disrespect intended, you say you are from Earth, but you are not applying any tax logic that we are accustomed to seeing here on Earth.

I apologize if you don't see the logic of equitable law challenges and remedies. Feel free to ignore this thread since it appears to be beyond your grasp.

Put asidthe emotions. Just tell us on what legal basis you'd be able to seek relief?

Put asidthe emotions. Just tell us on what legal basis you'd be able to seek relief?

My client's position is based on an equitable remedy notion that he should be allowed to make to the IRS and his State Taxation Dept (even if it is ultimately rejected) that it would not be fair for them to require payment of these Capital Gain taxes which are only due now because of the Corona Virus Pandemic and circumstances beyond his control, which prevented the completion of his 1031 Exchange and the resulting tax deferral, while at the same time Federal and State governments are attempting to help those that have been harmed by the Corona Virus Pandemic through stimulus payments, PPP loans and other similar relief measures.

Where is the cash TP got from the sale of the original property? Is the QI holding it? What has TP done to replace the sold property since the original replacement property transaction failed? Why didn’t he use the cash from the sale to purchase replacement property?

We’re having a hard time with the idea that the TP completed all steps but the main one: Buying a replacement property.

“Gain of a million dollars” means the original property sold for more. Again, who is holding the cash right now?

What kind of vacation rental property was this replacement property?

Isn’t one of the requirements to timely acquire replacement property (as SJR points out)? Yes, it is. Therefore, your client did not meet all 1031 requirements. Not even close. Your client got the cash, from a sale, did not timely replace, and now you want to take the position that there was not a taxable sale.

He did everything in a timely manner, so you are uninformed. The loans were drawn, the title company had the loan documents for the replacement property and the day he was set to go in and sign them, the lender pulled the loan because of covid. No other lenders would loan at that particular time including the seller. So, again, but for the Covid pandemic disaster the 1031 would have closed and the gain would have been deferred.

No preparer here will tell you to commit a fraud by filing an amended return that takes a frivilous position that a taxable sale wasn’t a taxable sale.

FRAUD? It would be fraud if he didn't report the sale. He reported it and we're simply looking for creative ways to have the State and IRS let us argue via an amended return that in a time when they are helping people impacted by Covid with stimulus checks, PPP loans, etc, that it's not equitable to at the same time impose a capital gains tax that only became due because of the same pandemic conditions. Right now the State won't even HEAR the arguments because we reported the gain on the original tax return and they won't allow an appeal on a tax your return shows you owe them.

There is no loss here, only a gain. The guy kept the cash, so what did he lose? Nothing.

FRIVOLOUS? Are you really this uninformed? If you sell a property and realize a taxable gain of a million dollars and the government lets you defer that gain and the tax due on it by means of a 1031 Exchange replacement property, how do you not lose the money if the gain can't be deferred and the IRS instead asks for the tax on it?

No disrespect intended, you say you are from Earth, but you are not applying any tax logic that we are accustomed to seeing here on Earth.

I apologize if you don't see the logic of equitable law challenges and remedies. Feel free to ignore this thread since it appears to be beyond your grasp.

Wanted to be sure to save the quote.